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Background
The Supreme Court in its recent judgment in the case of Southern Technologies Ltd.1 held that “provision for non-performing assets (“NPA”)” made as per Reserve Bank of India (“RBI”) directions does not constitute an expense for the purposes of section 36(1)(vii) of the Income-tax Act, 1961 (“the Act”) .
The Supreme Court held that as the provision for NPA is for presentation purposes and that it is notional in nature. Accordingly, no deduction for the provision of NPA, made by a Non-Banking Financial Company (“NBFC”), is allowable under the Act.
Facts
Southern Technologies Ltd. (“the assessee”) is an NBFC. The accounting year of the assessee was July to June and the financial statements were drawn up on 30 June for shareholders, RBI and the Registrar of Companies (“ROC”) under the Companies Act, 1956.
1 South Technologies Ltd. v. JCIT [2010-TIOL-01-SC-IT]
However, for income-tax purposes, separate financial statements were made for the year ending 31 March for computing the total income under the Act.
For the financial year ending 31 March, 1998 the assessee debited INR 8.17 million as aggregate provision towards NPA and claimed deduction under section 36(1)(vii) of the Act.
The assessing officer (“AO”) held that the provision for NPA is not allowable under section 36(1)(vii) of the Act.
The assessee, during the course of appellate proceedings before the Income-tax Appellate Tribunal (”the Tribunal”), claimed deduction for provision under section 36(1)(vii) on the grounds that the assessee was compelled to make provision for NPA and debit it to the profit and loss (“P&L”) account, as per Para 9(4) of the RBI directions. Further, the assessee submitted that consequent to such provision, there has been diminution in the value of its assets, specifically loans and advances, for which the assessee was entitled to a deduction under section 37 as a trading loss.
Provision towards NPA by an NBFC as per RBI norms not tax deductible Tax & Regulatory Services
News Alert*
15 January, 2010
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The Tribunal, following the judgment of the Gujarat High Court3, held that since the assessee had debited a sum of INR 8.17 million to its P&L Account, it was entitled to claim deduction as a write-off under section 36(1)(vii) of the Act. However, the High Court quashed the order passed by the Tribunal.
Issue
Whether the revenue is entitled to treat the provision for NPA, which in terms of the RBI Directions, 1998 is debited to the P&L Account, as “income” under section 2(24) of the Act, while computing the profits and gains of the business under sections 28 to 43D of the Act?
Assessee’s contentions
• Provision for NPA should be allowed as a deduction under section 36(1)(vii) of the Act, as a provision towards doubtful debt.
• If a deduction is allowable towards provision for doubtful debt under section 36(1)(viia) to banks and other prescribed financial institutions, the same should also be allowed to NBFCs.
Accordingly, if NPAs are akin to ‘doubtful debts’ as specified in section 36(1)(viia), then allowing deduction for such provision only to Banks and prescribed financial institutions would violate Article 14 of the Constitution of India.
• An amount written off as provision for NPA should be allowed on the basis of “real income theory”.
According to the assessee, applying the real income theory, the provision for NPA is in accordance with the RBI Directions, 1998. Accordingly, the provision can never be treated as income under section 2(24) of the Act and added back while computing profits and gains of business under sections 28 to 43D of the Act.
3 Vithaldas H. Dhanjibhai Bardanwala v. CIT [1981] 130 ITR 95 (Guj.)
• The accounting policy followed by the assessee is in accordance with section 145 of the Act. In this regard, the assessee contended that NBFCs are bound to follow the method of accounting prescribed by the RBI as per the NBFCs Prudential Norms (Reserve Bank) Directions, 1998.
As per the prescribed method of accounting, provision for NPA actually represented depreciation in the value of the assets. Accordingly, provision for NPA should be allowed as a deduction under section 37(1) of the Act placing reliance on the Supreme Court judgment in case of Woodward Governor India P. Ltd.4.
• There are several statutory liabilities such as provision for excise duty, gratuity, provident fund, ESI, etc. The Act disallows several such provisions under section 40A(7), 43B, 40 and 40A. However, the Act does not specifically disallow provision for NPA. Accordingly, unless provision for NPA is specifically disallowed under the Act, the same cannot be added in computing the taxable income.
Revenue’s contentions
• The Act is a separate code by itself and the total taxable income has to be computed strictly in terms of the provisions of the Act. Further, the Reserve Bank of India Act, 1934 (“RBI Act”) operates in the field of monetary and credit system.
The RBI Directions, 1998 are not in conflict with the provisions of the Act. However they constitute deviations from the presentation of the financial statements in terms of Part I of Schedule VI to the Companies Act, 1956.
• Provision for NPA is definitely not expenditure or a loss, it is only a provision against possible loss. Accordingly, no deduction can be allowed under section 36(1)(vii) of the Act for provision for NPA.
• Provision for NPA is in the nature of a “reserve”, which has been named as a
“provision” in the RBI Directions, 1998. Further, provision for NPA is notional in nature and should not be allowed as a deduction under the Act.
4 CIT v. Woodward Governor India P. Ltd. [2009] 312 ITR 254 (SC)
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Supreme Court Ruling
• NBFCs have to accept the concept of “income” as evolved by the RBI after deducting the provision against NPA. However, such treatment is confined to presentation / disclosure of the financial statements and has nothing to do with computation of taxable income under the Act.
Accordingly, though the RBI Directions, 1998 deviate from accounting policy, they could not override the provisions of the Act.
• By insertion of a new Explanation in section 36(1)(vii) (w.e.f. 1 April, 1989), it had been clarified that any bad debt written-off in the accounts of the assessee will specifically not include any provision for bad and doubtful debt. Accordingly, mere provision for bad debt would not be entitled to deduction under section 36(1)(vii) of the Act.
• Provision for NPA as per RBI Directions, 1998 does not constitute an expense on the basis of which deduction could be claimed by an NBFC under section 36(1)(vii) of the Act. Provision for NPA is an expense for presentation purposes, and in that sense, it is notional in nature.
• The Supreme Court, relying on certain judicial precedents5, held that the real profit can be ascertained only by making permissible deductions under the provisions of the Act. There is a clear distinction between the real profits and statutory profits.
Accordingly, any provision towards NPA should be added back to calculate the real profit under the Act.
• Section 37 of the Act applies only to items which do not fall in sections 30 to 36 of the Act. If a provision for doubtful debt is expressly excluded from section 36(1)(vii), then such provision cannot be allowed as deduction under section 37 of the Act.
• In the context of Article 14, the test to be applied is that of “rational / intelligible differentia” i.e. having nexus with the object sought to be achieved.
5 Poona Electric Supply Co. Ltd v. CIT [1965] 57 ITR 521 (SC) and CWT v. Bombay Suburban Electric Supply Ltd. [1976] 103 ITR 384 (Bom).
The Supreme Court analysed the rationale behind allowing a deduction under section 36(1)(viia) only to banks and not to NBFCs. Generally, banks face a huge demand from the industry, particularly in an emerging market economy, and at times the credit off-take is so huge that banks face liquidity crunch. Thus, the line of business operations of NBFCs and that of banks are quite different. It is for this reason that allowances of the nature mentioned in sections 36(1)(viia) and 43D of the Act are often applicable to banks and not to NBFCs.
Conclusion
The Supreme Court held that the provision for NPA made by NBFCs is for mere presentation purposes under the RBI Directions, 1998. Accordingly, any provision for NPA is notional in nature and is not allowable under the Act.
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